Deutsche Bank, others, using managed accounts more

Hedge fund investors look for more control after financial crisis

AlistairBarr

SAN FRANCISCO (MarketWatch) -- More investors in the $1.4 trillion hedge fund industry are using so-called managed accounts to gain more control over their money in the wake of the financial crisis.

Roc Capital Management LP, one of the largest hedge fund launches so far this year, is getting up to $500 million from Deutsche Bank
DB, -4.85%
through a managed account, a person familiar with the situation said Tuesday.

Calpers, the largest U.S. pension fund with roughly $170 billion in assets, proposed managed accounts for many of its hedge fund investments earlier this year. China's $200 billion sovereign wealth fund is also reportedly considering a similar approach when it invests in the industry.

Meanwhile, Ferrell Capital Management, a funds of hedge funds firm, is changing its business to focus on setting up managed accounts.

Managed accounts require hedge fund managers to run a segregated account on an investor's behalf, instead of putting the money in one big pot with all other investors. Because the accounts are held in the name of the investor, they can see exactly what positions managers are in at all times. Investors can also set limits on what kinds of securities managers can invest in.

These attributes have become more important to investors in the wake of last year's financial crisis, which triggered record redemptions from hedge funds.

During the recent credit boom, some hedge fund managers invested in securities that were less liquid than expected. When lots of investors wanted to pull their money out at the same time, managers couldn't quickly exit positions, so they suspended redemptions or limited liquidity in other ways, such as putting hard-to-trade positions in "side pockets" or erecting so-called gates.

Investors with managed accounts weren't affected such liquidity lock-ups. That's spurred more interest in the approach.

During the hedge fund boom earlier this decade, managers were reluctant to set up managed accounts because they're more restrictive and require more disclosure about potentially profitable positions. As investors clamored for access to top funds, managers could set terms that were more favorable to them. Now that balance is shifting.

"Equity hedge fund managers wouldn't do separate accounts because they didn't want us to see which stocks they were short," said Bill Ferrell, head of Ferrell Capital Management. "That's all changed now."

Ferrell has developed a new managed account platform known as Concert Hall. The firm is hoping to eventually convert its funds of hedge funds onto this platform.

It's trying to attract more capital from institutional investors so that it can offer to invest more money with each hedge fund manager as a way of encouraging them to set up managed accounts, Ferrell explained.

Roc

Roc Capital, run by former Deutsche Bank arbitrage trader Arvind Raghunathan, is due to start next month with up to $1.2 billion. The German lender has a managed account with Roc that allows it to invest between zero and $500 million with the new hedge fund firm, the person familiar with the situation explained.

Deutsche Bank set up the account because it gives the bank more liquidity and more insight into the portfolio, the person added on condition of anonymity.

'Game theory'

Calpers is looking for similar control of its hedge fund investments.

"Control will in many instances mean separate or managed accounts," the pension giant said in a March memo.

The usual method of investing in hedge funds, where money is co-mingled, leaves investors worrying about who might redeem when, Calpers explained.

"Investors who would otherwise be willing to 'ride out' what may be temporary price dislocations believe they are forced to redeem in order to avoid being left 'holding the bag' should other investors precede them out the exit door," the pension fund said in its memo.

"This turns hedge fund investing from a matter of assessing investment, strategy, and manager-related risks to a matter of 'game theory,'" Calpers added.

Setting up managed accounts will give Calpers the flexibility to make its own decisions about the viability of hedge fund strategies, the pension said.

"There is, after all, no need to concern oneself with gates or suspensions when there is only one investor in a fund," Calpers explained.

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